Beware of the second housing bubble

As with the stock and bond markets, there is a disconnect between the real world and the housing market. As Fitch Rating put it, "Demand is artificially high ... and supply is artificially low."

By Brenda P. Wenning/local columnist

MetroWest Daily News, Framingham, MA

By Brenda P. Wenning/local columnist

Posted Jun. 24, 2013 at 12:01 AM
Updated Jun 24, 2013 at 10:14 PM

By Brenda P. Wenning/local columnist

Posted Jun. 24, 2013 at 12:01 AM
Updated Jun 24, 2013 at 10:14 PM

» Social News

With all of the positive news reports about the improving housing market, you wouldn’t expect that we’re on the verge of another housing bubble, but that may, in fact, be the case.

The housing market is unquestionably improving, if you measure improvement based on the price of housing.

The Standard & Poor’s/Case-Shiller index data released recently shows that housing prices in March were up 10.2 percent from a year earlier – the largest annual gain since 2006. The index even showed an increase of 1.2 percent for the first quarter for the first time since 2006, even though prices are typically stagnant during the slow winter season.

But, as with the stock and bond markets, there is a disconnect between the real world and the housing market. As Fitch Rating put it, "Demand is artificially high ... and supply is artificially low."

Gluskin Scheff’s David Rosenberg referred to the stock market’s recent climb as a "Potemkin rally" because it’s based on actions by the Federal Reserve Board, not fundamental corporate performance or economic strength. Russian minister Grigory Potemkin created a fake village to impress Empress Catherine II during her visit to Crimea, giving us the term "Potemkin" to mean an illusion; reality propped up to look bigger and better than it really is.

Today’s housing market is likewise affected by Fed actions, but it’s a Potemkin village in reverse. While the Potemkin village gave us houses that weren’t there, today’s housing market has rallied based on buyers not seeing houses that are there.

This shadow housing inventory, which is yet another example of the market distortions created by a combination of quantitative easing and stimulus spending, is what Fitch is referring to when it says that the housing supply is artificially low.

Higher housing prices

So where did the shadow inventory come from? And why is it affecting housing prices?

It’s a matter of supply and demand. Low inventory is driving prices higher, as there are fewer homes for sale than there are potential buyers.

If housing prices were rising as a result of increasing consumer demand, that would be good news, as it would signal that consumers are ready to spend again and, presumably, have the money to spend, since they otherwise would not qualify for a mortgage. Instead, a shortage of supply has been driving prices higher.

There are plenty of homes available, including many that are vacant because of foreclosure. They’re just not on the market right now.

They’re not on the market because large, institutional investors have been buying them and renting them out. That’s creating the artificial demand referred to by Fitch. As writer and blogger Wolf Richter put it, "vacant homes don’t evaporate. Private-equity funds have poured tens of billions into gobbling up vacant single-family homes in specific markets."

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For example, private equity firm Blackstone Group LP invested more than $3.5 billion to purchase 20,000 vacant and foreclosed single-family homes, according to Bloomberg, and increased its credit line to $2.1 billion to buy more. Colony Capital LLC, which purchased 7,000 homes, is investing $2.2 billion more into home purchases.

It’s worth noting that the increase in prices noted by the Case-Shiller index is not uniform. Prices are increasing most in markets like Phoenix and Las Vegas, where the private equity firms are making most of their purchases.

While these institutional investors have been investing to take advantage of the hot market for rentals, the amount of rental property has increased to the point where supply is outpacing demand, so we can expect many of these homes to come on the market in the near future. Already, many of the purchased homes are vacant.

Once the houses come on the market, if supply outstrips demand, housing prices will likely drop again or, at the least, stop rising.

Barring dramatic economic improvement, supply is likely to outstrip demand because many Americans either can’t afford to buy a home or can’t qualify for a mortgage.

Many people are still out of work or are earning less than they did before the housing bubble burst. Based on current income and recent increases in housing prices, Zerohedge found that median new home prices are at an all-time high and homes are more unaffordable than they have ever been.

Many others cannot qualify for a mortgage because their credit scores were damaged due to a foreclosure or short sale. Even those who can afford a home may not have the 20 percent that is frequently needed for a down payment.

The growing number of Americans unable to afford a home has been a major factor driving demand in the rental market.

Higher interest rates

The potential increase in homes on the market is not the only factor that could shut down the housing recovery. If the economy truly is recovering, the Federal Reserve Board will be under increasing pressure to end its quantitative easing (QE) program.

As the Fed approaches $3 trillion in bonds in its portfolio, a growing number of people are recognizing that it can’t continue indefinitely. When QE does end, interest rates are bound to rise sharply. That will make homes less affordable, which will weaken demand, potentially leading to a drop in prices.

If, in spite of the evidence to the contrary, you believe the housing market is truly recovering, ask yourself why the price of lumber is plummeting. Typically, the price of lumber is a leading indicator of what’s happening to the housing market.

The federal government has done everything it can in recent years to make housing more affordable for Americans who can’t afford their own homes. Ironically, as a result of the latest government programs, housing is becoming so expensive, fewer and fewer Americans can afford to own a home.

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With a lack of qualified buyers, and the potential for increasing supply and rising interest rates, another housing bubble may be on the horizon.

Brenda P. Wenning of Newton is president of Wenning Investments LLC in Newton. She can be reached at Brenda@WenningInvestments.com or 617-965-0680. For additional information, visit her blog at www.WenningAdvice.com.